This is Kirk, here again at optionalpha.com.
In this video, I want to talk about before
we get into the specifics throughout this
course and this section on entering trades,
just talk about our logic and thought process
of how we go about making trades and just
a 10,000 foot view of what we’re trying
It’s obviously a game of numbers and I’ve
often said that when it comes to options trading,
we should run our business much like a casino
We all know that casinos make money, they
make money hand over fist, but it’s sometimes
hard to step back and to find out exactly
where their edge is.
We know that casinos make money and they have
an edge and they want us to play, but let’s
What does that look like and what are the
mechanics and logistics behind that because
there’s much more to it than just the percentage
that they’re going to win or lose on a given
trade or a table game.
It comes down to sizing, table limits, number
of times that people play or roll the dice.
There’s a lot that goes into it and we should
act much like a casino does, but we often
do the complete opposite and you’ll see
How does a casino really make money and what’s
their edge that they have over us?
How do we quantify that?
Let’s start with roulette.
Admittedly, roulette is one of the worst odds
games, but it’s actually one my favorite
ones to play.
I mean, go figure.
I like playing it and I don’t go there to
But when I go, I like to play roulette.
I don’t follow all the things with poker
and the different players at the table.
I just like to play roulette and bet on the
different numbers and spaces.
But when it comes to roulette, (and we know
that game with the wheel that spins and the
marble that falls) most often, people will
bet on red or black and it’s pretty normal
for somebody to go into a casino and just
put all their money or red or black or whatever
the case is.
But here’s the exact way that it’s paid
You can see the payout is 1:1.
That means if you bet $1, they’ll pay you
$1 if you win and if you bet $1 and you lose,
you lose $1.
That’s how the payout works.
It’s pretty fair as far as risk and reward.
You put up $50, you could make $50 or lose
But here’s where the casino’s edge comes
into play and there’s two different ones.
There’s the European probability which European
roulette wheels only have one green zero and
they do a little bit better as far as probability.
Us Americans, we get hammered and we have
two double zeros on our roulette wheel and
that means that our probability is even lower.
But you can see that the probability of this
happening, either one of these, red or black
is just about 48% to 47%.
Even though you’re making $1 for every $1
you put up at risk, the likelihood of you
keeping that is 47% which means that the casino’s
edge is somewhere around 2.5% to 3%.
That’s how we can find out what the casino’s
edge is because every time that we make this
trade, theoretically, we’re losing about
2.5% to 3%.
It’s not a lot.
It’s not like the casino is robbing you
of your money immediately.
But over time, you can see how this really
And you can see the number of total times
it can happen and the colors and everything
and the numbers that are covered in this.
As we go down on the roulette odds, you can
see that probability of red or black is about
46%, 47% depending on how you calculate it
and who you look at and the number of occurrences.
But you can see that the odds of that happening
even with just even numbers that have 1:1
payouts are pretty much the same.
The casino is not going to rake you over the
calls and take all your money at once.
They want you to stay longer and they want
you to play longer.
And then obviously, as you get further and
further down, the probability of hitting any
one number on the roulette wheel decreases
dramatically, but the payout is obviously
a lot higher.
Instead of being 1:1, they’ll payout 35:1.
If you put up $1 in money to bet and you hit
it, you’re going to make about $35 for every
$1 that you put up.
Big payout, but it’s got a very small likelihood
of actually happening.
Why table limits?
You’ve often heard that when you go to a
casino that the casino will have a little
sign posted there that says that this table
has a table limit or a bet limit of say $50
Having table limits increases the number of
“plays” that a person will make which
thus increases the house edge back to the
The longer you play, the more you stand to
lose and that’s period, end of story, there’s
no debating it.
Casino’s deliberately wants you to make
lots of plays and play a lot and they want
you to do it with a small amount of money.
I often say and I’ve done a podcast on this
too, is that if you walked into a casino and
you told the casino manager, “I want to
bet $1 million on red right now.
One bet, $1 million on red, one roll, one
spin and that’s it.”
And they would absolutely hands down say,
99% of casinos would say “Absolutely no
way” because their one-time probability
of losing on that bet is about 47% that they’re
going to lose to you, so it’s too big of
a bet in one full swoop.
What they would want to see is they want to
see you spread that $1 million over thousands
of different bets.
They limit the amount of money that you can
bet on any one roll or any one play because
they know that the more you spin, the more
you roll, the more behind that you become.
Here’s a great chart that really shows this
and this is with roulette, the odds of going
with a black or red or even an odd number,
so just one spin.
If you spin it one time and the wheel goes
around one time, you’re likely to be behind
on average about 51%.
Remember, you’re getting paid 50/50 if you
win, so your risk is almost exactly the same
as your reward payout wise.
Over the course of 100 spins, the percentage
that you would get behind is about 64%, so
you’re still in the game here, you’ve
been playing for a while, but now you’re
starting to lose more and more of that edge
to the casino.
And over 1,000 spins then over more importantly
10,000 spins, you can see that on a given
night, over 10,000 spins, you have no chance
of keeping any of the money that you started
The longer you play, the less consistent you
In fact, consistency drops exponentially the
longer that you play because that small house
edge that we looked at before, 2.5% to 3%
slowly goes back to the casino.
And this is why they want us to play longer
This is why they have great deals on casino
trips and they offer you free rooms and free
food because the longer you play, the more
money that’s going to get sacked back to
Having said all of this, as traders and more
importantly as options traders, we need to
follow the same logic with how we run our
business and you have to think of it as a
business to begin with.
This isn’t a hobby.
This is something you do on the side.
You have to run this thing like a business
and that means that you have to one, make
high probability trades.
When you go to a casino, you’re not making
any high probability trades.
There’s a small edge to the house.
In trading, we know how to make high probability
trades and we can do that.
Number two is we’ve got to keep our position
We’ve got to set table limits for ourselves.
We can’t go in there like I often say like
a rodeo cowboy just slinging money around
left and right.
You got to go in there and you got to make
small bets based on your position size.
We’ve got a great guide inside Option Alpha
in the guides and checklist section that helps
you determine your position size based on
a bunch of different account sizes.
And number three, we have to understand that
consistency is what leads to profits, so being
able to make high probability trades with
small positions over a long stretch of time.
And going back to the casino example, they
didn’t really have a 100% chance of success
in winning until they had 10,000 spins.
That doesn’t mean that we’ve got to make
10,000 trades, but that does mean that one
or even 100 trades over the course of a year
may not get us to that consistency level that
we want, but we’re assured that if we keep
making high probability trades and keep setting
table limits for ourselves that we will see
success the longer and longer we stay in it.
That’s why guys in this business who have
been in it five years and 10 years become
more and more successful because they’ve
just made more trades.
If they stay consistent and persistent, it
will lead to profits.
Hopefully this has been a really good tutorial
just to get you started before we get into
a lot of the logistics of entering trades
and how to manage some of those entry points
and looking for trades.
It’s important to take a step back and understand
the 10,000 foot view of what we’re trying
to do here.
As always, if you guys enjoy this video, please
share it online, on Twitter, on Facebook.
Add a comment right below this video in the
lesson page if you have any questions.
I’ll make sure I get back to all of those.